SMALL CAPS BREAK SUPPORT -- MIDCAPS MAY BE NEXT -- DOW AND S&P 500 BREAK 50-DAY AVERAGES -- AIRLINES LEAD TRANSPORTS LOWER AS UTILITIES RALLY WITH BONDS -- EMERGING BONDS FALL ON RISING DOLLAR
SMALL CAPS FALL BELOW AUGUST LOW -- MIDCAPS MAY BE NEXT... Arthur Hill and myself have been warning of a potential breakdown in smaller stocks, and the potential damage that could do to the rest of the stock market. That situation has gotten even worse. Chart 1 shows the Russell 2000 Small Cap Index having fallen below its August low. In so doing, it has also established a negative pattern of "lower highs and lower lows" since the start of July. That puts the RUT in position to threaten even more important chart support along its February, May lows. Midcap stocks are also threatening chart support. Chart 2 shows the S&P 400 Mid Cap Index slipping below its 200-day moving average (for the first time in two years), and threatening to break its early August low. A close below that previous low would complete a bearish "double top" reveral pattern formed during July and August. That would also have a negative impact on large cap stocks.
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Chart 1
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Chart 2
S&P 500 FALLS TO SIX-WEEK LOW... Large cap stocks are starting to weaken as well. Chart 3 shows the S&P 500 Index trading well below its 50-day average, and trading at the lowest level since mid-August. At the very least, a further decline is likely to its early August intra-day low (1904) which would also result in a test of its 200-day moving average. That would represent a modest correction of 5-6%. It's important that the SPX find support in that area to prevent a more serious breakdown. The 14-day RSI line (above chart) has fallen below the 50-line after failing to confirm the recent high in the SPX. Daily MACD lines (below chart) have also turned down. Those short-term divergences take on more meaning after the market has completed a five-wave adance, which it's done since the start of the year (see boxed numbers). A five-wave advance is usually followed by a drop to the bottom of wave four (4). That would also bring the SPX back to the 1900 level.
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Chart 3
DOW INDUSTRIALS AND TRANSPORTS BREAK 50-DAY LINES -- UTILITIES BOUNCE ... Chart 4 shows the Dow Industrials falling below their 50-day average for the first time in six weeks. Chart 2 shows the Dow Transports doing the same. A big drop in airline stocks (on rising ebola fears) is hurting that group. Chart 3 shows the Dow Utilities gaining more than 1% and climbing back above its 50-day line. The utility bounce is coming on the back of a flight to safety in bonds. Bond yields are tumbling and Treasuries are rallying. Transportation selling, combined with utility buying, signals a more defensive shift in the market.
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Chart 4
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Chart 5
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Chart 6
CORRECTION THREAT GROWS ... Last Wednesday's message wrote about weakness in various breadth measures that warned of a possible market correction. They include the % of NYSE stocks trading above their 50- and 200-day moving averages, which have since fallen to 25% and 47% respectively. The latter number means that more than half NYSE Index are in major downtrends. Weakness in foreign stocks was also mentioned. EAFE iShares and Emerging Markets iShares are both trading below their 200-day averages. The stronger dollar is taking a toll on emerging market assets. A drop in emerging market currencies has hurt their respective stock markets. The same is true of their bonds. Chart 7 shows the Emerging Markets Local Currency Bond iShares plunging to a six-month low. That means that money is fleeing those higher-yielding bonds quoted in local emerging currencies (and moving into Treasuries). A higher dollar (and expectations for higher U.S. rates) reduces the appeal of those higher-yielding bonds. Weakness in foreign developed and emerging stocks is beginning to weigh on U.S. stocks. Global markets are positively correlated. They become even more tightly correlated when volatility starts to rise. Which it may be doing.
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Chart 7
VIX NEARS TEST OF AUGUST HIGH... Chart 8 shows the CBOE Volatility (VIX) Index rising to the highest level in nearly two months. In so doing, it is nearing a test of its early August closing peak just above 17.00. A close above that previous peak would put the VIX at the highest level since March and signal an intermediate uptrend. The VIX Index (which trades in the opposite direction of stocks) has remained relatively contained since January. A rise above its August high would change that. The fact that we're in the dangerous month of October is also adding to market nervousness. No doubt, the reason the VIX is rising is because traders are buying "put" protection. That may not be a bad idea. [Option traders buy "puts" to protect against a market downturn].
